Planning for profit
Knowing how much income your farm needs to generate is an important question for farming success but it’s not always an easy one to answer. A basic understanding of your farm’s income, expenses and your profit target is a good starting point.
The formula for success
Your farm income must cover all the running costs of the farm to produce a farm profit (or loss). The farm’s profit is what pays back loans, pays taxes and is available to re-invest in your business as well as pays for your living expenses.
So, to answer the question “How much income does the farm need to make?” it is sometimes better to first determine how much profit is required to pay for these things. Having a profit target helps to understand the size and type of business you need to produce the income you require.
We can use this simple formula below:
Farm profit target = Farm income – direct expenses – overhead expenses
Direct expenses are directly attached to farm production systems. For example, shearing costs for a sheep enterprise or chemical costs for cropping. Once these direct expenses are deducted from income, we have your farm’s gross margin.
Overhead expenses are the ones you cannot avoid and are attached to the business whether it is producing or not. Examples include insurance, council rates, permanent workers, administration and accounting costs and vehicle registrations. Once the overhead expenses are deducted from the gross margin, we are left with farm profit. This is our target.
One of the challenges of working through this equation is that often the numbers don’t add up –your profit target cannot be met because there is too little left once direct and overhead expenses are deducted.
Some of the reasons may include:
- The farm is too small and cannot produce the required income
- Direct or overhead expenses are too high
- The expectations of the business are too high.
Where the expectations of the business are too high, the business may be performing well but it can’t (and won’t) produce enough profit to fund all the that is asked of it.
How to determine your target profit
When determining target profit, it is best to lay it all out on paper to ensure you include every expense, including living expenses that you are looking to support.
Include items such as living expenses, medical costs, holidays, debts, capital investments on-farm, school and university fees and don’t forget to include a little extra for ‘other expenses’ that unexpectedly but inevitably pop up each year.
If you’d like help working through a budget of your own, a RFCS Rural Financial Counsellor can guide you via phone or in person (where COVID restrictions permit).
Profit planning – can it be done or are we asking too much?
Now that you understand what your target profit is, the planning process can be relatively simple. Your past financial records may show if you have a track record of generating this amount of profit. Looking forward, some simple budgeting, either by yourself or supported by your local Rural Financial Counsellor, will determine if the current scale and type of farm business is enough to meet the target profit.
Of course, seasonal variations in yields and commodity prices have a big influence on the outcome. The lack of certainty of these factors makes it tempting to skip the planning process. However, the small amount of time and effort it takes is worth it to have outlook and confidence in decision making.
It’s important to note that financials prepared by your accountant aim to reduce tax and so deliberately play down the financial performance of the business. As such, you may need to be carefully interpret your financials to get the real story of the business’s performance. Also, in your budgeting process, it is important to use average production and market prices so that you do not over or underestimate the capacity of the business.
Remember, if after detailed analysis the target profit is unachievable, a realistic plan may need to include work off-farm to reduce the pressure from the business and provide for the needs of the family.
Goal and strategy setting – how to identify short and long-term actions for generating income and reaching your target profit
Goals are the best way to identify what matters in our business. They determine where you are going to focus your time, energy and resources. Often, people start with broad or long-term goals like “To generate enough profit to cover all expenses and grow wealth for our family while operating our farm in a safe and sustainable manner”.
The values expressed in a broader goal like this will help define the limits and opportunities of the business, so these need to be well-considered. For example, if being certified organic is part of the goal, then the boundaries are clear for your business straight away.
However, following on from your broader goals, it is important to set SMART goals – specific, measurable, attainable, relevant, and time-bound. These SMART goals are usually shorter-term and will help drill down into the specific activities needed to reach the broader goal. Generally, there will be several SMART goals for your broader goal.
A SMART goal may be to “Understand the individual gross margins of each crop and livestock enterprise in the business, and to assess against industry benchmark gross margins within the next six months”.
Having a target profit and a plan to achieve it will not make it rain or increase market prices. However, it will provide the framework to better understand the options and opportunities available to your business and make timelier and ‘bigger’ decisions more confidently. It helps lift you out of the detail to focus on the bigger picture and what can and needs to be done to improve your financial situation.
And remember to reach out to your Local Financial Counsellor as a second set of eyes (and use of their skills and knowledge) can be a huge help to start the process for your farm business.